Is Business Loan Interest Tax Deductible? Section 163(j) Rules

Interest on a business loan is generally tax deductible. Section 163(a) of the Internal Revenue Code allows a deduction for interest paid or accrued during the year on indebtedness, and interest on money borrowed for your trade or business qualifies as an ordinary and necessary business expense.¹² That covers term loans, lines of credit, business credit cards, and equipment financing. How much you can deduct in a given year, and when, depends on how you used the money, how big your business is, and what the loan is funding.

Two things have to be true before any of this matters. The debt has to be a real obligation, meaning a genuine debtor-creditor relationship with an expectation of repayment. Loose arrangements between family or partners sometimes fail this test and get recharacterized as gifts or equity, which kills the interest deduction. And the expense has to be ordinary and necessary for your business — common in your industry and helpful to your operations, though not indispensable.³

What Makes Interest “Business” Interest

Deductibility turns on how you spent the borrowed money, not what you pledged to get the loan. The IRS calls this the tracing rule, and it’s set out in Treasury Regulation 1.163-8T: interest follows the debt, and the debt follows the use of the proceeds.⁴ Put your house up as collateral to buy business equipment, and the interest is fully deductible as business interest. Draw on a business line of credit to remodel your kitchen, and that interest is personal.

Mixed-use loans get split. If you borrow $100,000 and put $80,000 into inventory and $20,000 into personal expenses, 80% of the interest is a business deduction and the other 20% is personal. Personal interest is not deductible at all for individuals under Section 163(h).⁵ Records that show exactly where the money went are what protect the deduction if the IRS asks.

The Section 163(j) Cap on Business Interest

Even when interest clearly belongs to your business, a separate rule under Section 163(j) can limit how much you deduct in a given year. The cap is business interest income plus 30% of adjusted taxable income (ATI), plus any floor plan financing interest.⁵ Most small and mid-size businesses never run into it.

Small Business Exemption

If your average annual gross receipts over the prior three tax years don’t exceed $32 million (the inflation-adjusted figure for tax years beginning in 2026), the cap doesn’t apply to you.⁶ Tax shelters are excluded from this exemption regardless of size.⁵

ATI Calculation Starting in 2026

For tax years 2022 through 2024, depreciation, amortization, and depletion were not added back when computing ATI, which made the cap bite harder for capital-intensive businesses. For tax years beginning after December 31, 2024, those deductions are added back again, which raises ATI and gives businesses more room to deduct interest.⁷ If your business runs large depreciation deductions, that change matters.

Interest Disallowed This Year Carries Forward

Interest over the cap isn’t lost. The disallowed amount carries into the next tax year and is treated as if paid or accrued then.⁵ It’s subject to the same 30% test in the following year, so a business with persistently high interest can push disallowed amounts forward for years.

Businesses That Can Elect Out

Electing real property trades or businesses, electing farming businesses, and certain regulated utilities can opt out of the Section 163(j) limitation entirely, regardless of size.⁷ The tradeoff is that they must use the alternative depreciation system for certain property, which means longer recovery periods and no bonus depreciation on things like nonresidential real property and qualified improvement property. For a real estate business holding property long-term, the tradeoff often works; for others, it needs modeling.

When Interest Has to Be Capitalized Instead of Deducted

Some business interest doesn’t get an immediate deduction at all. Under Section 263A(f), interest on debt used to produce certain long-lived or long-production-period property has to be added to the cost basis of the property and recovered through depreciation over time rather than deducted currently.⁸ The rule captures real property you produce (constructing a building, for example), tangible personal property with a class life of 20 years or more, property with an estimated production period over two years, and property with a production period over one year and estimated costs over $1 million.

Small business taxpayers meeting the $32 million average gross receipts test for 2026 are generally exempt from Section 263A capitalization, including the interest capitalization piece.⁹

Interest You Can’t Deduct Even for a Business

Personal interest. For non-corporate taxpayers, interest that isn’t allocable to a trade or business, investment, passive activity, or qualified residence is not deductible.⁵
Interest the IRS charges on income tax deficiencies. It isn’t a business deduction, even when the underlying tax is on business income.
Interest on debt used to carry life insurance, annuity, or endowment contracts. Generally nondeductible, with a narrow key-person exception capped at $50,000 of debt per person.
Commitment fees and standby charges. Fees to keep a line of credit available aren’t interest. They may still be deductible as a separate business expense, but not under the interest rules.

When You Get to Claim the Deduction

Timing depends on your accounting method. Cash-method taxpayers deduct interest in the year they actually pay it. Accrual-method taxpayers deduct it in the year it accrues, regardless of payment.

Prepaid interest is where cash-basis filers get caught. Under Section 461(g), if you pay interest covering a period past the current tax year, you have to spread it over the periods it covers.¹⁰ Pay 12 months of interest in December when only one month falls in the current year, and you deduct one month now and eleven next year. The same principle blocks a common workaround: you can’t deduct interest on a new loan by paying it with a second advance from the same lender. The deduction starts when you actually make payments on the new obligation.

Where to Report Business Interest on Your Return

Where the deduction goes depends on how your business is organized:

Sole proprietors and single-member LLCs report deductible interest on Schedule C (Form 1040), lines 16a for mortgage interest paid to banks and 16b for other interest.¹¹
Partnerships and multi-member LLCs report on Form 1065.
C corporations report on Form 1120.
S corporations report on Form 1120-S.

For partnerships and S corporations, the deduction is calculated at the entity level, and the resulting income or loss flows through to the owners’ personal returns.

Form 8990 If You’re Subject to the 163(j) Cap

Businesses subject to Section 163(j) file Form 8990 (Limitation on Business Interest Expense Under Section 163(j)) with their return. It’s required for any taxpayer with business interest expense, a disallowed business interest carryforward, or excess business interest expense from a partnership.¹² You can skip Form 8990 if you qualify as a small business taxpayer under the $32 million gross receipts threshold and have no excess business interest expense from a partnership. Pass-through entities that allocate excess taxable income or excess business interest income to their owners have to file the form even when the entity itself has no interest expense.

1
Office of the Law Revision Counsel. 26 U.S. Code 163 – Interest
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Office of the Law Revision Counsel. 26 U.S. Code 162 – Trade or Business Expenses
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Internal Revenue Service. Ordinary and Necessary
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eCFR. 26 CFR 1.163-8T – Allocation of Interest Expense Among Expenditures (Temporary)
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Office of the Law Revision Counsel. 26 USC 163 – Interest
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Internal Revenue Service. Rev. Proc. 2025-32
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Internal Revenue Service. Questions and Answers About the Limitation on the Deduction for Business Interest Expense
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Office of the Law Revision Counsel. 26 U.S. Code 263A – Capitalization and Inclusion in Inventory Costs
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Internal Revenue Service. Interest Capitalization for Self-Constructed Assets
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Office of the Law Revision Counsel. 26 U.S. Code 461 – General Rule for Taxable Year of Deduction
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Internal Revenue Service. Instructions for Schedule C (Form 1040)
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Internal Revenue Service. Instructions for Form 8990 – Limitation on Business Interest Expense Under Section 163(j)